tinyBuild: the new gamer on the block

London's stock market has become a feeding ground for big video games companies. In the space of less than a year, two foreign businesses have scooped up a London-listed developer. Electronic Arts (US:EA) snapped up racing game specialist Codemasters for £945m toward the end of 2020, and this month Chinese tech giant Tencent (HK:700) reached a takeover agreement with Sumo (SUMO) that has valued it at £919m. 

For developers then, London clearly is a venue that will support their growth, as well as keep a door open for a lucrative takeover deal. And while some investors may be hoping for the latter for newly Aim-quoted tinyBuild (TBLD), we think this developer has the capacity to deliver impressive growth rates on its own. 

E-sports player turned chief executive Alex Nichiporchik co-founded the tinyBuild label with Luke Burtis, who is now chief operating officer, back in 2011 in an attempt to develop a small-joke game into a full title on the online gaming platform, Steam. The idea was greeted happily by fans of the game – and a public kickstarter hit its funding goal within hours of going live.

What followed was less fun for the Seattle-based company. As an independent (or ‘indie’) developer, tinyBuild's bosses lament that the company went through “years of hell” before making any money after an unnamed publisher did not follow through with its funding. So they aimed to make tinyBuild the supportive publishing partner it never had and since August 2013 tinyBuild has coupled with dozens of other indie developers, producing third-party games on top of its own original content. 

The IP edge 

But since 2016, the company has been transitioning away from third-party content towards its own-IP: a strategy that was cemented by the success of its Hello Neighbor title a year later. The game, a stealth horror about sneaking into a neighbour's home, has been expanded into a multimedia franchise beyond games and into merchandise and books. It already has a sequel lined up for next year, the test version of which has been downloaded more than 6 million times. 

Besides a boost to revenue growth and the accumulation of loyal fans, the development of tinyBuild’s own-IP portfolio should feed into the long-term improvement of its profit margins, as the company sheds the burden of profit-splits with external developers. What’s more, the creation of a hit brand such as Hello Neighbor - which has been nominated for several awards since its first release - is an important intangible asset, and contributes to what business strategists refer to as a “moat”. Management can return to its enduring franchises and fan base to tap revenues again and again. 

It is worth noting too that IP often acts as a strategic driver to merger and acquisition (M&A) activity, as companies pursue access to specific types of content, markets and customers. 

That said, tinyBuild’s existing portfolio of games looks robust. In 2020, it generated three-quarters of its sales from its back catalogue; 35 of its titles contributed 68 per cent of those sales, so not only is the IP strong, the life cycles are too. This sort of effective management is reflected in a rate of return on capital employed – which measures how effectively money is invested into a business – that stands at an impressive 25 per cent.

Acquisition and execution

But tinyBuild shares comes with a dose of risk. First, the company and its developers – both internal and external – face infamously tough industry deadlines although, so far the pressures of remote working have not caused launch or service delays, unlike at some peers. Potential investors would also take on some execution risk: developing a game is a resource- and time-intensive task, and must be well-received by pundits in order to pay off. 

There is also risk in the group’s so-called ‘acquihire’ strategy. This is when tinyBuild targets a specific developer team or content from an external company, and selectively acquires IP via an asset purchase, rather than a full corporate acquisition. It is the method through which the company bought the IP of Hello Neighbor from developer Dynamic Pixels. That said, integration risk is often lower than via a traditional takeover, especially as tinyBuild usually already has a commercial relationship - on average at least three years old - with its target. And so far, tinyBuild has completed seven ‘acquihires’ since 2013 – including three in 2020 for a total cash consideration of $0.6m, before transaction fees. With upwards of $70m net cash following its March flotation, including lease liabilities, tinyBuild's bosses should be able to pursue this strategy comfortably in the near future.  

The scope of the gamer boom

Active M&A is an encouraging sign for investors in the video-game industry, as companies show they are willing to fork out in order to capture its growth. Research firm Mordor Intelligence has estimated that the global gaming market was worth $174bn in 2020, and will reach $314bn by 2026, representing a compound annual growth rate of 9.6 per cent. Such potential is hard to resist; it has even tempted streaming giant Netflix (US:NFLX), which announced last week that it was developing its own mobile gaming products. 

The scope for crossover into media has not gone unnoticed by tinyBuild’s management. This month the company announced the appointment of industry veteran Nick Van Dyk to its board, the former co-president of Activision Blizzard (US:ATVI). Prior to that he spent a decade at Walt Disney (US:DIS), and so should be able to provide useful insight, as well as connections, in the broader media industry. tinyBuild is already in early talks to produce an animated TV series based on Hello Neighbor - a pilot episode of which already has close to 17m views on YouTube.

The road ahead 

Even as pandemic restrictions lifted and the market braced for a hit to video game sales, tinyBuild reported this week that its revenues are progressing “at least in line” with expectations for 2021. 

HOW TINYBUILD COMPARES WITH LONDON-LISTED PEERS

True,tinyBuild has a very limited record as a quoted company, having joined Aim only in March this year. The shares are 33 per cent up on the float price, but with 26 new game launches in the pipeline, a more lucrative focus on own-IP and industry growth developing at pace, we think they should have much further to run. With “accretive acquisitions” on the horizon, that view seems to be the City consensus. All four brokers that cover the stock rate it as a ‘buy’, according to data compiled by FactSet. Sure, the rating might look forbidding, with the shares trading at 40 times 2022's forecast earnings. Nonetheless, analysts are bullish, with an average target price of 310p, 38 per cent above the current price. Buy.